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Scenarios: How the world can tackle skewed growth and FX
October 21, 2010 / 4:43 AM / 7 years ago

Scenarios: How the world can tackle skewed growth and FX

SEOUL (Reuters) - Finance leaders are trying to reconcile their differences over deep imbalances in the global economy and reduce the risk of a currency war.

Talks at the meeting of Group of 20 finance ministers and central bankers this week in South Korea and of their leaders in November should reveal the struggle among these diverse economies to find common ground on policies and currencies.

Below are possible ways forward for addressing uneven global growth and currency tensions, evident in China’s export might and its yuan currency, and the declining dollar in face of slow growth and high debts of many rich economies.

GIVE IMF AN ENHANCED ROLE AND REFORM IT

PROBABILITY: High.

This is the route that countries agreed to try at their meetings in Washington earlier in October. A lot of work remains on details and to make any agreement work.

The International Monetary Fund’s 187-member countries have agreed that urgent action is needed to give the IMF a more assertive role in highlighting the economic policies of countries that could cause currency problems, and that toughened scrutiny of rich countries is a priority.

Dominique Strauss-Kahn, the IMF’s managing director, has proposed drawing up “spill-over reports” on how the economic policies of the world’s five largest economies -- the United States, China, the euro zone, Japan and the United Kingdom -- affect each other.

The reports would build on existing IMF powers, known as Article IV annual reviews, where the IMF examines the economic policies of all its 187 members and makes recommendations. But the IMF has struggled to get governments to heed its calls for tough reforms.

If toughened review powers can be twinned with a giving a bigger voice to developing countries at the IMF, which traditionally is dominated by the West, the proposal may gain momentum. With debate over currencies and current account balances heating up, it is likely any say on IMF reform will be left to the G20 leaders at next month’s summit in South Korea.

Similar approaches to build on the Article IV reviews have failed twice in the past. China balks at calls for reform of its currency system. In the past it has even blocked publication of its IMF review. European countries have also ignored Fund suggestions that they undertake politically sensitive reforms, such as to their labor markets.

Hence there is some skepticism why this time should be different.

USE THE G20 TO THRASH OUT CURRENCY DIFFERENCES

PROBABILITY: France will try it next year, big challenge.

The Group of 20, representing the leading developed and emerging economies, last year became the main forum for discussing the global economy, overtaking the G7.

G20 finance ministers and central bank governors meet in South Korea on October 22-23 before a leaders’ summit in Seoul on November 11-12. The G20 traditionally issues a communiqué which could lay out a common stance on how to redress global imbalances and relieve pressure on currencies.

Countries have indicated that currencies will be a major theme at the meetings. One proposal is a limit on current account balances, although it also seems certain officials will baulk at any one-size-fits-all norm.

Privately, officials from some rich countries grumble that the G20 is too unwieldy for detailed debate of complex issues and informal discussions with some of the G20’s biggest members are more fruitful.

But France, which assumes the G20 presidency in 2011, has said there is no obvious alternative to the G20 for discussing currencies. French President Nicolas Sarkozy wants to make review of the international monetary regime a centerpiece of his G20 presidency next year.

Brazil has suggested the G20 should work on a “new Plaza Accord” -- the landmark 1985 pact under which five countries (United States, Japan, Britain, West Germany and France) engineered a dollar depreciation via currency market interventions and economic reforms. U.S, officials too seem to favor some norms on FX policy. But few expect such explicit prescriptions in a more complex world.

G7 PLUS CHINA THRASH OUT THEIR DIFFERENCES

PROBABILITY: Unlikely

The economic powers of the 20th Century that make up the Group of Seven -- the United States, Japan, Germany, Britain, France, Italy and Canada -- could invite China to join them to work out their differences.

The currencies of the G7 -- U.S. dollar, yen, euro and Canadian dollar -- account for the bulk of the $3 trillion in daily trading volumes in global foreign exchange markets.

Including China in talks with the G7 financial leaders on currencies would be essential because it is the world’s biggest exporter and has amassed $2.45 trillion in foreign exchange reserves while keep the value of the yuan down.

The head of the euro zone finance ministers, Jean-Claude Juncker, told Reuters on Friday that the G7 plus China would be the “ideal forum” for discussing currencies.

But the G7 is a waning forum and no longer issues formal communiqués and China would probably refuse to join a group whose other members are all likely to put it under pressure to revalue the yuan.

A G7-plus-China format would also probably be resented by other emerging economic heavyweights such as Brazil, Russia and India. An alternative would be G7 plus the BRICs but there has been little serious discussion of such a grouping recently.

DO NOTHING

PROBABILITY: Likely

One possibility is that countries cannot agree on how to coordinate and instead pursue national policies, reversing the remarkable unity seen after the credit crisis exploded.

The backlash over the budget deficits is leading to fiscal retrenchment and retreat to national solutions, particularly in Europe. The risk is that taking fiscal policy off the table when monetary policy is near exhaustion and growth still fragile will feed uneven growth, heightening currency misalignments and spill over into currency and trade wars.

China’s central bank governor Zhou Xiaochuan said on Friday that currency problems might fade away when the rich economies finally recover. A hands-off approach would suit China which does not want to change its yuan policy.

Developing economies in Latin America and Southeast Asia would either have to cope with further strengthening of their currencies, as investors pour money into their high-yielding bonds, or attempt costly interventions and controls, risking an outbreak of trade protectionism and policy discord.

USE A NEW RESERVE CURRENCY

PROBABILITY: Highly unlikely in the short term.

China and Russia favor moving the global economy away from reliance on the U.S. dollar as the world’s primary reserve currency. They have floated the idea of using Special Drawing Rights, a synthetic IMF unit made up of a basket of currencies. This would make countries less reliant on the value of the dollar, now used as the primary medium for world trade. In the meantime, China is striking more bilateral agreements to trade in the yuan and bypassing the U.S. dollar.

Shifts in world currencies take years if not decades, as seen with the decline of sterling before World War II and then the abandonment of the dollar peg from 1968 to 1972.

French President Sarkozy wants to examine international monetary arrangements as part of his G20 presidency next year.

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For a PDF report “Currencies: Race to the bottom”

r.reuters.com/gez77p

Reshaping financial regulation: r.reuters.com/zys68p

Package of graphics on currencies, trade and monetary policy:

r.reuters.com/deh58p

G20 graphic: link.reuters.com/men39p

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